Why Do Traders Make Mistake 'Using too much Leverage'?

﻿

Unfortunately, the blunt answer to the question "why do traders use too much leverage" is "ignorance." This is not to imply that everyone who trades futures is ignorant (although there are those who might debate this). What it means is that many traders are unaware of the amount of leverage involved. Too many traders get into futures trading without realizing or understanding the amount of leverage involved. People who trade stocks for years (putting up $1 of cash to buy $1 of stock) often mistakenly assume that they are doing the same thing with futures. They simply don't realize that when they put up $1 they may actually be buying or selling $33 worth of the underlying commodity. Few people are prepared to deal with 33-to-1 leverage. To make matters worse, those who don't even realize they are using 33-to-1 leverage have almost no hope of surviving. It is sort of like taking a test drive in an Indy race car. You know it can go fast so you prepare yourself a little, but you are used to driving the family sedan whose top speed might be 80 miles an hour. So you strap yourself in, put your foot on the gas and suddenly find yourself hurtling down the track at 220 miles per hour. The odds of your avoiding a serious accident are slim. And so it is, too, for the unenlightened futures trader.

Another problem is that there are few warnings given regarding how much leverage is too much. Brokerage houses make money based upon the number of trades made so they don't have a great incentive to tell somebody "you're using too much leverage; you should trade less." Another problem is that although there have been many good books written regarding money management, there remains no standard method for determining the proper amount of leverage to use when trading futures.